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  • Bottom fishing or Covered stock?

    October 5, 2009 by  
    Filed under Hedging, Options, Stock Trading

    Q: I am a member of the DMA and had some questions regarding SRS. I want to enter this trade but do not know if I should be bottom fishing it or buying a covered stock, due to the following:

    – Bottom Fishing: negative skew / am considering selling the Oct 9 Put / buying Jan 8 Put
    – Covered Stock: high IV – for each 100 shares bought I am risking around $140, which seems “expensive”

    Any thoughts you can share with them. Is there another alternative I could be considering?

    A: It depends on whether you are bearish or bullish on srs.

    The ‘bottom fishing’ trade you mentioned is bearish. You will only make a profit is srs falls to 9 (max profit). You max loss is the debit you pay for the spread and you will have a max loss if srs rises by the October expiration.

    If you’re bullish I would recommend the covered stock rather than the diagonal position.

    The reason why the covered stock is seemingly expensive is because srs has a high beta (high volatlity) so the premiums are generally high but you can adjust the risk by going deeper into the money on the put side.

    You didn’t say what strikes you were going to use for your covered position… but I would look for a put with an .80 delta if you want to reduce your downside risk – you’ll pay a little more for the protection but if srs declines you will have good protection.
    You’ll also get unlimited upside potential if srs continues to rise.

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